S&P Global Ratings expects funding costs will rise for U.S. and Canadian nonbank financial institutions through 2025 as interest rates remain high and maturities rapidly escalate.

Financing conditions for U.S. and Canadian nonbank financial institutions (NBFIs) and financial services issuers more broadly improved in the second half of 2023 and remain steady, despite ongoing market volatility and uncertainty on when the Federal Reserve will cut interest rates. As the risk of recession has faded and inflation has eased, investors are looking toward eventual interest rate cuts, which has intensified demand for new issuance.

Much of the debt that matured in 2023 and that is expected to mature in 2024 was issued during the era of low interest rates that ended in 2022, when the Fed began raising interest rates to combat inflation. With interest rates expected to remain high at least for the first half of 2024 and gradually decline by year-end, companies that have been paying low interest rates will be forced to refinance at much higher rates.

S&P Global Ratings economists expect rates to come down but remain high this year, with three rate cuts of 25 basis points (bps), likely starting in the summer. But much will depend on inflation, consumer spending, and the labor market. S&P Global Ratings economists now expect the economy will grow 2.5% in 2024 before falling below trend in the next couple of years.

We expect most rated companies, especially those rated 'BB-' or higher, to cover the higher interest expenses with operating cash flow without relying on incremental borrowings. Some companies might start to reduce leverage as they absorb the much higher refinancing rates. In preparation for rising rates, many companies accumulated significant debt in 2020 and 2021, which will mature at an increasing pace over the next 12-24 months. While we expect these maturities to be mostly manageable, escalating maturities will add to financing pressure, especially for companies that have weak cash flow and earnings.

Maturing NBFI Debt Peaks In 2026

The 99 NBFIs that issue debt and that S&P Global Ratings publicly rates in the U.S. and Canada have about $225 billion in debt outstanding, about 12% (approximately $27 billion) of which was raised in 2023. Over the next five years, these companies have about $126 billion in nonrevolving, nonsecuritized debt maturing, with a peak of $37 billion in 2026. About 45% of total outstanding debt is speculative-grade (rated 'BB+' or lower) (see appendix for individual debt maturity profiles).

Consistent with trends in NBFI issuance, U.S. speculative-grade financial services issuance in 2024 so far is maintaining 2023's brisk pace, with nearly $12 billion in issuance through February--up notably from the lows of 2022 (see chart 1). Meanwhile, credit spreads for speculative-grade financial services bonds have narrowed to 307 bps as of Feb. 28, 2024, near their tightest in five years (see chart 2).

Chart 1

Chart 2

U.S. investment-grade (rated 'BBB-' or higher) financial services issuance has rebounded in 2024 after a decline in 2023 (see chart 3). It's up 78% over 2023's volume (through February)--off to its fastest start in more than four years.

Credit spreads for U.S. financial services bonds have been narrowing in recent months as well (see chart 4). Composite credit spreads for investment-grade financial services bonds have narrowed by 39 bps since the beginning of November, to 116 bps, near their tightest in two years.

Chart 3

Chart 4

Pace Of Issuance Increased In 2023 Despite High Interest Rates

While overall NBFI issuance was up slightly in 2023, companies addressed their maturities differently in the first and second halves. In the first half, higher rates and wider spreads allowed higher-rated companies to opportunistically use excess cash to chip away at their maturities by engaging in debt buybacks through open-market transactions.

Yet while the debt markets were open for investment-grade companies, speculative-grade companies had to grapple with execution risk and pricing uncertainty. This provided a window of opportunity for private credit, in particular direct lenders, to step up and provide certainty on execution, albeit at a premium relative to the public markets.

In the second half of 2023, which accounted for 55% of debt issued for the year, credit spreads tightened from their highs earlier in the year. This allowed many NBFIs to access the unsecured markets and refinance their upcoming maturities, albeit at higher rates than the debt maturing.

Speculative-grade issuance rebounded in 2023 and represented 55% of total issuance for the year (see chart 5). Of the $14.6 billion issued by speculative-grade NBFI issuers, about 72% was raised by commercial real estate (CRE) lenders and servicers, consumer finance companies, and residential mortgage companies. Among investment-grade issuers, business development companies (BDCs) and alternative asset managers represented the largest share of issuance, at 63%.

Chart 5

BDCs and commercial lenders, CRE lenders and servicers, consumer finance companies, and asset managers accounted for about 75% of the debt raised by NBFI companies in 2023 (see chart 6). The remaining 25% was split among residential mortgage companies, money/payment services, and other subsectors.

Chart 6

Maturities Rise Through 2026

In our view, the amount of debt maturing in 2024 is manageable, at around $6.0 billion between 13 companies, down from $18 billion a year ago. Still, we expect refinancing risk will remain an important rating consideration for NBFIs as debt maturities likely increase to about $19.9 billion in 2025 before nearly doubling to $37.4 billion in 2026.

The longer rates stay high, the more they will pressure debt service coverage metrics, even for higher-rated companies that will have to refinance at the new rates. Higher short-term rates continue to affect borrowers with floating-rate debt--most of which are speculative-grade--along with borrowers issuing or rolling over debt.

In addition to higher base rates, companies with weak operating performance will experience wider spreads, amplifying the pressure on debt service coverage ratios and credit ratings. Furthermore, we expect higher interest rates will force some companies to prudently manage excess cash flow by scaling back on shareholder-friendly behavior, such as buybacks and special dividends, to either reduce leverage or fund portfolio growth.

We expect investment-grade companies will maintain easier access to capital. Of the roughly $126 billion of NBFI debt maturing over the next five years, we rate about 47% investment-grade. Within the investment-grade category, $38.4 billion is rated at the 'BBB-' level, primarily from BDCs. Within the speculative-grade category, $42.6 billion of debt is rated in the 'BB' category, $22.0 billion in the 'B' category, and $2.5 billion in the 'CCC' and below category (see chart 7).

Chart 7

NBFIs represent a small share of total debt, so the maturities of financial and nonfinancial companies more broadly will weigh more heavily on financing conditions. We estimate that nearly $6.0 trillion in debt (including bonds and loans but excluding revolving credit facilities) from financial and nonfinancial issuers is scheduled to mature in 2024-2028 in the U.S. and Canada, and about 29% of this is from financial services.

Financial services maturities peak around $400 billion in 2026--considerably lower than recent bond issuance volumes, which have held above $450 billion annually for each of the past three years (see chart 8). By comparison, nonfinancial corporates show a much steeper rise, with maturities more than doubling to a peak of $1.16 trillion in 2028.

Much of the nonfinancial corporate debt maturing in 2028 consists of instruments issued in 2020 and 2021. By contrast, pandemic-era debt doesn't have such an overhang among financial services issuers.

Chart 8

Most NBFI Sectors Will Have Manageable Debt Maturities

The amount of NBFI debt maturing through 2028 represents a narrow slice of North American financial services debt maturing over the same period. But in our view, many NBFIs play important roles in providing funding and liquidity to leveraged borrowers, while others play critical roles in providing various financial services to consumers. As a result, we believe tighter financing conditions for NBFIs could spill into the broader credit markets.

We generally expect most NBFI sectors to have manageable debt maturities over the next five years. Of the roughly $126 billion of debt maturing between now and 2028:

• $45.4 billion is from BDCs and commercial lending;
• $19.6 billion from traditional asset managers;
• $12.2 billion from money/payment companies;
• $11.2 billion from consumer finance;
• $9.9 billion from CRE;
• $9.9 billion from the residential mortgage sector; and
• $9.7 billion from alternative asset managers.

Chart 9

Higher Rates Will Elevate Funding Costs

We expect new issuance to remain high this year on increasing investor risk appetite and higher returns in unsecured markets. Amid the rally in interest rates and the continued tightness of credit spreads, the debt markets have generally been open for most NBFIs. However, any refinancing is at higher interest rates relative to existing debt costs.

Further, high interest rates have weakened the profitability and liquidity positions of many companies and pushed some lower-rated companies into default. Distressed debt exchanges have increased among NBFIs as lower-rated companies with unsustainable capital structures look to refinance their debt. We will continue to monitor such transactions as refinancing risk starts to rise in 2024-2025. Meanwhile, higher-rated companies continue to absorb the higher debt costs and show resilience.

We still think well-staggered debt maturities, coupled with ample liquidity via revolving credit facilities and cash, is the best strategy for issuers to maintain credit quality. Issuers with concentrated debt stacks will face the greatest risk of refinancing near-term maturities, while those with well-staggered debt and adequate liquidity can wait for pockets of market volatility to pass.

Sector-Specific Considerations

Asset managers

Our view of the traditional asset management sector remains negative for 2024, while our views for the alternative asset management and wealth management sectors remain stable:

• Traditional managers are the most exposed to market volatility, and net outflows could compound this pressure for some.
• While wealth managers are similarly vulnerable to market movements, their asset base is stickier, resulting in more stable earnings. However, we expect sustained high rates to particularly affect wealth managers due to their high leverage and proclivity for debt-funded inorganic growth.
• Alternative asset managers are the best positioned of the three, considering the locked-up nature of their assets under management, solid fundraising records, diversified platforms, and capital available for deployment during market dislocation. That said, prolonged weak investment performance and lower realizations could affect performance-related income.

Credit metrics will weaken for some asset managers should earnings decline. We also expect high interest rates to continue to compress interest coverage metrics, particularly for issuers with significant variable-rate debt exposure or those that need to raise capital over the near term. Most issuers' liquidity remains well positioned, with few near-term debt maturities after many issuers refinanced over the past few years while capital costs were low.

Auto finance

We expect auto loan origination volumes to increase in 2024 as consumer demand remains robust. That said, a rise in credit loss reserves and higher costs of funds to support growth could squeeze profitability metrics for the auto lenders we rate. Auto loan delinquencies and losses already rose in 2023, and we expect the same trend in 2024 because of weakening borrower performance, higher interest rates, and declining recovery rates.

As supply-chain constraints have largely subsided, we expect used car prices to decline in 2024, potentially leading to lower recovery rates and increasing the loss given default for lenders. While subprime auto lenders have no operating lease exposure, a broader decline in used car prices could affect the recoveries these lenders can realize through auction sales on repossessed vehicles.

Auto fleet management

Auto fleet management companies continue to record healthy revenue growth, supported by strong origination volumes and elevated used car prices. We expect robust origination demand in 2024 as more businesses look to outsource vehicle management operations; that said, vehicle backlogs continue to delay revenue generation. As supply constraints ease through 2024, more of the backlog will convert to revenue. Nonetheless, we expect used car prices to stabilize in 2024 from their recent peak, offsetting some of the growth from origination.

Higher interest rates offset strong revenue growth in 2023, lowering EBIT coverage metrics for rated companies. We expect high interest rates to continue to pressure EBIT coverage until rates start to decline in the second half 2024.

BDCs and commercial credit

We expect new originations to regain momentum in 2024 as companies look to refinance their upcoming investment maturities. Expected tighter banking regulations, direct lenders' ability to write larger checks, and a rise in club deals will continue to allow direct lenders to compete with broadly syndicated loans.

Given the aggressive interest rate hikes last year, we anticipate the interest coverage ratios of the underlying borrowers of BDCs and commercial lenders will decline further, since many borrowers have not experienced the rate hikes' full impact. Higher-for-longer interest rates and wider credit spreads could lead to weaker credit quality for BDCs and commercial credit lenders, through a rise in nonaccruals and payment-in-kind income within their portfolio companies.

Commercial real estate lenders

We expect CRE lenders will continue to face headwinds, but the extent of credit quality deterioration will depend on location, property type, and the underwriting quality of the properties securing the loans. To navigate difficult market conditions over the next year, we expect CRE finance companies will remain selective with new originations and focus on preserving liquidity. Many CRE lenders' distributable earnings have dropped recently, prompting some companies to cut their dividends to protect liquidity.

Loan portfolios will likely deteriorate further for CRE finance companies, particularly those with high office exposures. Multifamily loans have also come under strain due to slowing rent growth and high interest rates. A rise in troubled multifamily loans could exacerbate asset quality issues because most CRE lenders have been increasing their exposure to multifamily since 2020 as an offset against office exposure.

CRE finance companies typically have expertise in dealing with troubled properties, and handling stressed or defaulted loans could involve amending and extending maturities, seeking partial loan paydowns, foreclosures, or other strategies. Most of these strategies, however, have a negative ratings impact due to resulting deterioration in leverage or earnings.

Commercial real estate services

We expect subdued CRE capital markets and leasing activity will persist through the first half of this year. CRE occupiers and investors have delayed their decision-making and lowered the average deal size, owing to high interest rates and macroeconomic uncertainty. The elevated dry powder and robust leasing pipeline set the stage for an eventual recovery of CRE transactions, but the timing and path of recovery remain unclear.

We expect CRE services companies to benefit from substantial recurring (albeit lower-margin) property and facilities management earnings and to better withstand the revenue contraction from their transactional business lines. Most CRE services companies achieved robust growth in property and facility management in recent years, owing to new client wins and portfolio expansion with existing clients--a trend that we expect will continue as companies seek to reduce costs by outsourcing property management.

Consumer finance

We expect the likelihood of higher unemployment, coupled with the lingering impact of higher inflation and the resumption of student loan payments, will continue to burden consumers' ability to repay loans. As a result, we expect net charge-offs and delinquencies will continue to rise in 2024. Consumer demand remains robust, and we expect lenders to modestly loosen credit underwriting by focusing on originating more secured than unsecured and smaller-denominated loans, given better recovery prospects in the event of default.

As always, regulatory changes could affect the lending strategies of consumer finance companies. While regulatory risk at the federal level in the U.S. has waned over the past few years, state governments continue to make regulatory changes that cap interest rates on personal loans at 36%. The Canadian government also announced its plan to reduce the cap on interest rates to 35%. Further regulatory rate caps pose significant risks to companies.

Residential mortgage

High mortgage rates, lack of home supply, buoyant home prices, and reduced purchasing power, which we expect will compound difficulties for residential mortgage companies, will likely continue to challenge mortgage origination volume in 2024. In particular, the sharp decline in refinancing volume has led to lower gain-on-sale margins and weaker profitability. We expect residential mortgage origination volume to be up just slightly in 2024, largely due to purchase volume.

A possible decline in mortgage rates is unlikely to spur a surge in refinancing volume because many existing borrowers have already taken advantage of lower rates. While some mortgage companies will pursue growth opportunistically as the industry consolidates, we expect most companies to keep focusing on expense management in 2024.

We expect continued growth of mortgage servicing right (MSR) portfolios at companies with strong servicing platforms. Some mortgage companies curtailed or exited certain lending channels, and we expect them to continue seeking MSR purchases and subservicing agreements. As interest rates remain high, we expect mortgage servicing assets to hold their value because of low prepayment speeds and refinancing activity. At the same time, companies that have deployed tighter MSR hedging programs have protected themselves from a potential decline in MSR valuations.

Money transfer and payment processing

Despite difficult macroeconomic conditions, most money transfer and payment services companies achieved modest top- and bottom-line growth in 2023. Revenue sources for the sector are very diverse, including global money remittance, commercial fleet fuel cards, point of sale, peer-to-peer, travel, health care, toll roads, and ATMs.

Capital allocation strategies will likely diverge among the companies we rate. Companies that performed well through 2023 might increase stock buybacks, which will largely limit surplus cash available for netting against debt. Others will look to acquire complementary businesses at discounted valuations, which could entail higher debt, depending on the size of the target.

Appendix

Related Research

• Declining Asset Quality And Funding Obstacles Follow U.S. Finance Companies Into 2024, Jan. 24, 2024
• Stabilizing Interest Rates Ease Pressure On Asset Managers, Despite Headwinds, Jan. 22, 2024